Monday, May 24, 2010

A More Just Tax, Part IX: Freedom from the Slavery of Savings

By Norman G. Kurland, Dawn K. Brohawn, and Michael D. Greaney

In the previous posting we decided that a single tax rate of 50% on all income from whatever source derived is reasonable given the colossal debt problem — meaning that it would be bearable if imposed on incomes of over $30,000 for a non-dependent and $20,000 for a dependent. We can, however, expect that individuals in the upper brackets will protest that the bulk of their income derives from dividends and capital gains, which are usually taxed at more favorable rates than wage incomes. This is to encourage reinvestment of corporate profits in order to finance economic growth and provide wage system jobs. The income from these jobs can then be taxed instead of dividends and capital gains. Is that, however, the most efficient and cost-effective means of financing more universal participation in economic growth and capital formation?

Not according to Dr. Harold Moulton in his classic 1935 study of financing investment, The Formation of Capital. As we pointed out in the previous posting, by cutting consumption (which is what, effectively, reinvestment is), economic growth is slowed dramatically. In extreme cases, where money is created for non-productive uses and reinvested in speculation or gambling (as was the case in 1929 and again in the recent economic "downturn"), the resulting "readjustment" in the economy can be devastating in its effects.

For comparison, let's first assume that Capital Homesteading will not decrease the Federal budget at all, and that the single tax rate is 50%. Further assume, however, that the personal exemption plus deductions is $30,000 per non-dependent, and $20,000 per dependent, that corporate dividends and inflation-indexed capital gains are taxed once as ordinary income at the individual level, and not at all at the corporate level (i.e., dividends are tax deductible), and — this is very important — social units such as families can aggregate their exemptions and deductions.

Even without reductions in the Federal budget, the effective tax rate on incomes of less than $150,000 would be under 16-2/3% — substantially less than now — while the effective tax rate on income of $1 million would be 45%. Still, an effective rate of more than 45% on incomes of $1,000,000 or more is pretty high. It is much higher than the approximately 15% rate often paid on qualified dividends and capital gains. Taxes on dividends and capital gains are a political football, depending how well the government juggles the growing need for cash against the illusion of the need for past savings to finance capital formation. In any event, wage income above $1 million is relatively rare, and most people with incomes at that level receive it in the form of dividends and capital gains — on which they receive extremely favorable tax treatment, when they are taxed at all.

We have to take into account, however, the actual "double taxation" of dividends and the effective double taxation of capital gains. The effective double taxation of capital gains is a reflection of the value of retained earnings, which represent undistributed corporate income on which taxes have been paid. Given the usual double taxation, is the favorable tax treatment for dividends and capital gains all that "favorable"? Looking at how dividends and capital gains are currently taxed for a single individual gives a somewhat different picture. Assuming a 15% tax on dividends and capital gains and a 35% tax on corporate profits, we get a 50% total tax rate on dividends and capital gains — which is the same rate we have provisionally calculated for all income under a Capital Homesteading single rate tax. For the wealthy, then, Capital Homesteading would be "tax neutral," while it would substantially lower taxes for the non-wealthy.

These figures do not materially change when we factor in the current level of personal exemptions and the standard deduction. Many rentiers (small investors) do not qualify for itemization if they've been financially prudent. The figures do, however, increase if we factor in a corporate tax rate greater than the 35% minimum we used in the calculation. The "favorable" tax treatment under the current double- and triple-taxation is not quite as "favorable" as many people suppose. Finally, if we remove the extremely unpopular favorable tax treatment of dividends and capital gains and tax such income at the highest marginal rate of 35%, adding that 35% to the 35% corporate tax levied on corporate income in excess of $18.3 million results in an effective tax rate on the wealthy of 70% — certainly more than the proposed estimated 50% single rate under Capital Homesteading.

Reducing the Federal Budget: Looking Forward to 2050

All of the above assumes as a given that the current estimated federal budget will not decrease in any way; that any decreases in expenditure will be applied to reducing the debt or meeting the estimated $74 trillion shortfall in Social Security and Medicare. We have to keep in mind, however, that the income generated by individual Capital Homestead Accounts will at first supplement, and eventually replace virtually all transfer payments, Social Security, Medicare, and other entitlements, and that the personal exemption and a negative income tax (or vouchers) will be taking care of education and health care. Private charity will be able to handle much of what remains in hard cases, so that government welfare and entitlements will diminish to the absolute minimum necessary to maintain an emergency "social safety net."

Our previous example assumed that only half the entitlement budget would disappear, but within two generations, all current promises will have been kept, and former entitlements will have been changed to rare emergency payments to help those rare individuals whose Capital Homestead Accounts have failed to generate sufficient income to meet the greatly increased tax exempt income. It may not be too much of a coincidence that the potential reduction in the federal budget achieved by eliminating entitlements — $2 trillion — is approximately equal to the annual "growth ring" of new capital added to the U.S. economy.

This suggests that widespread ownership through Capital Homesteading has the capacity in and of itself to cover the Social Security, Medicare, and all other entitlement budget shortfalls. It is also consistent with former U.S. Comptroller David Walker's statement that entitlements make up two-thirds of the federal budget. We need, however, to add in a provision for the negative income tax, whether in the form of direct cash payments or vouchers. Realistically, this would be taken care of by the increase in the tax base combined with decreases in federal spending, but we are, again, being as conservative as possible.

Assuming that the average income below the new individual "poverty level" ("Subsistence Level Necessary to Meet Common Domestic Needs Adequately" would be a more accurate description, but "Poverty Level" is embedded in the public mind, and needs no lengthy explanation.) of $30,000 (the amount of the personal exemption) is exactly half of the new poverty level gives us $15,000. This means that an additional $15,000 would be needed on the average for each person in poverty to bring him or her up to the poverty level. According to the Census Bureau, 37 million Americans live in poverty, which we will round up to 40 million.

Obviously, increasing the "poverty level" to $30,000 would, in and of itself, vastly increase the number of Americans living in "poverty." This is offset by the fact that the Federal Reserve Board estimated total consumer debt as of 9/30/07 at $2.482 trillion, or approximately $8,000 per capita. (Recent news reports indicate that this has increased to $9,000, but this has not been verified.) Adding in mortgage debt (characterized by former Federal Reserve Chairman Alan Greenspan as a "bubble") of $3.001 trillion gives an additional $10,000 of per capita debt, much of which was revealed to exceed the value of the homes on which the mortgage was made.

In effect, each American family of four has a debt burden of $72,000. We are forced to conclude that families are spending far beyond their actual incomes, and are already effectively, if not officially, living in poverty. The needs of these individuals and families are being met out of non-existent savings (increases in debt) or by various forms of State welfare or redistribution.

Taking only the "non-revolving" consumer debt figure of $1.5 trillion supplied by the Federal Reserve for September of 2007 (ibid.) ("non-revolving" meaning debt that must be paid in the current period, and not renewable, or "revolving"), gives a per capita amount by which each individual lives beyond his or her means each year of $5,000 ($20,000 for a family of four). Subtracting $5,000 from the basic exemption of $10,000 plus the health care deduction of $7,000, and assuming that there are no education expenditures or Capital Homestead investment gives $12,000. This amount is close to the current "poverty level" of $9,973 for an "unrelated individual," and slightly under the $12,755 for a "Family of Two."

This suggests that our Capital Homesteading reforms will not appreciably increase, and should even reduce the number of persons under the "poverty level" even as the "poverty level" is dramatically increased. This will be accomplished by allowing individuals and families to meet common domestic needs adequately without such pervasive recourse to consumer debt.

A significant amount of this "increased" income (actually taxes that are not paid until income from all sources exceeds $30,000) will result from folding Social Security and Medicare taxes — currently at around 15% (Currently individuals pay half, or approximately 7.5% of the Social Security and Medicare tax, while employers pick up the other half. By folding Social Security and Medicare into the general tax rate on individuals, employers will no longer be charged the other half of Social Security and Medicare taxes. This will free up profits to pay out as dividends, or increase wage incomes, both of which would increase consumption incomes under Capital Homesteading.) — into the general, single tax rate, and not on all wage income below the existing statutory limit. This will mean an effective increase in consumable income of $4,500 on wage incomes of $30,000.

Multiplying our new "half poverty" level of $15,000 by 40 million persons gives us an "add back" to the Federal budget of $600 billion in negative income taxes. We round this down to $500 billion due to the fact that we originally rounded up the number of people in poverty. We also did not take into account that there are probably no individuals receiving absolutely no income, and, as the economy gears up for full production, far fewer people will receive the negative income tax, and those in decreasing amounts as personal income rises with the creation of jobs in a fast-growth economy combined with increased capital income from Capital Homestead Accounts.

Adding $500 billion back into the reductions of $2 trillion leaves us with a rough estimate of the Federal Budget under Capital Homesteading of $1.5 trillion — half the anticipated budget before the current bout of mega-spending on bailouts and stimulus. Using these new figures to calculate the single tax rate once Capital Homesteading has empowered individuals and families to accumulate a significant amount of income-generating assets (less than 40 years, given the anticipated increase in economic growth) gives us $1.5 trillion divided by taxable GDP of $6.3 trillion, or 23.81%. This is a much more palatable figure, less than the current corporate tax for larger businesses, or the individual marginal tax rate of persons in the higher brackets — and remember that if a family of four pays no taxes on aggregate income of less than $100,000, paying taxes at all means a family is already in what is today regarded as a "higher bracket" before it begins paying taxes.

If it were possible to eliminate all welfare (an unrealistic expectation, of course), we would have a tax rate calculated by dividing $1 trillion by $6.3 trillion, or 15.87%. Still, being able within a generation to reach the hitherto "unreachable star" of full employment by including full employment of capital combined with widespread ownership thereof, should eliminate poverty as a permanent condition of life for an estimated 13% of Americans, leaving the negative income tax to succor the truly unfortunate, instead of trapping people into an unbreakable cycle of poverty.

This version of the single rate tax represents a revolutionary restructuring of the Welfare State based on class warfare and redistribution, to a welfare state based on the economic empowerment through capital ownership of every citizen as a fundamental right of citizenship and self-governance. This, of course, would make the State more dependent on the citizens, rather than having the citizens increasingly dependent on a "Big Brother" form of government.

A tax rate of 23.81% is, however, still a high figure — but what does it really mean? The median income in many states today is below $40,000, according to the Census Bureau (the average median income of all 50 states, the District of Columbia, and Puerto Rico is a little over $68,000), so what would the real or "effective" tax rate be? Let us assume that people making less than $100,000 take all their income in the form of wages. This is actually not too unrealistic, for most middle class investors do not spend any dividend and capital gain income, choosing to reinvest what they might have for retirement.

Let us further assume that, in an attempt to meet the present value of the projected shortfall in Social Security and Medicare, the $74 trillion or so (Thomas R. Saving, "$74 Trillion = Crisis", The Wall Street Journal, March 9, 2005, A20. Mr. Saving, a senior fellow at the National Center for Policy Analysis, is the director of the Private Enterprise Research Center at Texas A&M.) will be raised (or will try to be raised) by levying the approximately 15% tax on all wage income up to $100,000, of which the employer pays half, or 7.5%.

Now we compare today's taxes with what would be paid after the system has been in place for a generation, assuming that the Capital Homestead reforms are adopted in their entirety. Assuming a family of four, the aggregation of personal exemptions, a single personal tax rate of 23.81%, — rounded up to 25% — and Social Security and Medicare merged into the general single tax rate, a four-person families with an aggregate income of $100,000 or less would pay no taxes. Within a generation it would not be until a family had aggregate income of more than $250,000 that the family's entire tax rate would be even close to the current Social Security tax (of which self-employed individuals pay both "halves," whether they make $1 or $100,000), much less today's income tax.

The effective tax rate only gets above 20% for incomes in excess of $500,000, while someone making a million dollars in annual income would pay less than 23% — less than the current marginal tax rate of approximately 35% on wage income in that bracket, and substantially less than the nearly 70% paid on "non-wage" income in the form of capital gains and ordinary dividends once the politically and economically non-viable favorable tax treatment is removed.

Conclusion: The Goals of the Capital Homestead Act

A tax system that conforms itself to common sense and the goals of the Just Third Way embodied in the proposal for a Capital Homestead Act would, obviously, advance the goal of establishing and maintaining an economically just social order. This is the goal of Capital Homesteading and, of course, the Just Third Way. A tax system based on common sense and a minimum number of easily understood and straightforward rules and regulations intended for the sole purpose of raising revenue for the State in a manner consistent with the Just Third Way would also solve what is rapidly becoming the most overwhelming, even disastrous problem facing the world today, the colossal mountain of debt resulting from decades, even centuries of incredible financial mismanagement and counterproductive government spending. The Capital Homestead Act is designed to:

1) Generate millions of new private sector jobs by lifting ownership-concentrating Federal Reserve credit barriers in order to accelerate private sector growth linked to expanded ownership opportunities, at a zero rate of inflation.

2) Radically overhaul and simplify the Federal tax system to eliminate budget deficits and ownership-concentrating tax barriers through a single rate tax on all individual incomes from all sources above basic subsistence levels. Its tax reforms would:

a) eliminate payroll taxes on working Americans and their employers;

b) integrate corporate and personal income taxes; and

c) exempt from taxation the basic incomes of all citizens up to a level that allows them to meet their own subsistence needs and living expenses, while providing "safety net" vouchers for the poor.